Lurking behind the daily gyrations of the stock market is a deeper story about the threat coronavirus carries to the global economy — a story that Congress needs to understand and act on now to stave off a potentially devastating recession.
There are economic problems caused by Covid-19 illness itself, like closed Chinese factories making components unavailable to other parts of the supply chain. But there’s a separate threat to the global economy. It’s an issue of demand, which can cause ripple effects that would potentially outlast direct disruption of the economy.
Since the pandemic began, global demand for every kind of raw material from industrial metals to staple crops like wheat and soybeans has dropped. Businesses know that means global spending is going to slow and so they take measures to prepare, like idling workers and reducing output. Already the aviation industry, which was initially shifting aircraft from China routes to other opportunities, is just settling for flying fewer planes and paying fewer workers.
The good news is that governments can step in to prevent mass firings by promising to spend money to keep demand stable. But companies are acting as though they do not believe the governments will act.
Congress and legislatures around the world need to promise now that measures will kick in automatically if the worst begins to happen. If they wait until then, it’ll be too late.
Supply and demand
A global pandemic sounds deceptively like a supply-side problem: China shut a bunch of factories down to halt the spread of infection and now there’s no hand sanitizer to be had and Apple products are backordered.
But that’s not all that’s happening. We’re looking at what a college econ textbook would call a shock to the demand side of the economy on top of the supply-side disruptions.
A demand shock is something like what started to happen when American house prices began to slide downward in 2007 and 2008. Because prices were declining, investors get less interested in building new houses. And because prices were declining, homeowners felt poorer and became less likely to make major purchases.
These negative demand effects started to ripple through the economy. With sales of cars and major appliances on the decline, manufacturers reduced production and laid workers off. The decline in housebuilding also generated layoffs. Laid-off workers reduced their spending, and even employed people started to get fearful and pull back. Slower economic activity led to weak state and local budgets, who in turn cut spending.
Next thing you knew, it was a recession. Central banks try to fight recessions by cutting interest rates to encourage new investments and major purchases, and Congress can also step in with fiscal stimulus designed to fill the spending void.
A supply shock, by contrast, is something like a bad harvest or a war disrupting global oil production. The world’s physical capacity to make stuff — wheat, gasoline, whatever — goes down which raises prices and creates problems for business. In contrast to a demand side recession, in the face of a pure supply shock you can’t really stimulate the economy. You can do your best to address the underlying problem, or else you can just ride it out and hope next year is better.
The world has a bad demand problem
Either kind of shock can lead to a stock market decline. If Apple can’t sell iPhones because nobody wants to buy them (demand problem), that’s bad for its share price. If Apple can’t sell iPhones because the factory where they’re assembled is closed (supply problem), that’s also bad for its share price.
But it’s important to distinguish a supply shock from a demand shock because the solutions are different.
We can look at financial market indicators besides stock prices to draw a clear distinction.
The global price of oil, for example, has fallen dramatically in the past month. The price of wheat has fallen too. Prices for industrial metals like copper and zinc have fallen. Sometimes prices can fall for good reasons — a bumper crop or a technological innovation that allows for a huge increase in production. But when the price of basically every kind of raw material or basic commodity is falling, you are probably looking at a worldwide slowdown in spending.
The prices of government bonds are telling a similar story. When investors don’t really want to invest in anything, they park their money in loans to safe governments, which pushes down the interest rates those governments need to pay.
The interest rate on a 10-year US government bond has fallen to below 1 percent. A German 10-year bond carries an interest rate of negative 0.87 percent. The same is happening throughout the developed world. From Canada and Australia to Japan, Switzerland, and Denmark interest rates — already very low by historical standards before the virus struck — are falling lower as investors give up on basically anything.
These kind of financial market indicators are less familiar to many people than share prices, but read together they tell a clear story of a global demand crisis.
Last but by no means least, consider this somewhat unfamiliar measure. The US government sells two kinds of 10-year bonds. One pays out a given interest rate specified in nominal terms. The other promises to pay such-and-such more than the rate of inflation. By comparing the interest rate on the nominal bond to the one on the inflation-protected bond, we can see what financial markets think is going to happen with inflation. In this case, they think it is going to go down and be below the Federal Reserve’s 2 percent target rate.
This is a double-whammy — demand is collapsing and investors do not believe that world governments will provide enough stimulus to prevent price drops. This is potentially a recipe for a serious recession, one that might last longer than the direct disruptions induced by the disease unless action is taken.
From pandemic to demand shock
Start with airlines. Currently executives are warning that the slowdown in global travel demand they are experiencing “could be worse than 9/11,” and airlines all over the world are cutting flights as fewer people want to fly. That’s going to reduce orders for new aircraft and hurt manufacturing in the United States, Europe, Canada, and Brazil, where airplanes are made.
Fewer flights is also going to mean fewer people in airports. Fewer people in airports is going to mean reduced hours and tips for people who work in airport retail. If the typical airport retail worker was sitting on a fat savings account, they could dismiss the hit to their income as temporary and probably take advantage of some discounts. But we know that most working-class people, even in a very rich country like the United States, more or less live paycheck to paycheck (they are “liquidity constrained” in economics jargon) and can’t actually take advantage of any good shopping opportunities unless they have money coming in.
Then there’s Seattle, which has seen the most cases in the United States Covid-19 outbreak.
Karen Weise and Kirk Johnson reported for the New York Times that “in pockets all around Seattle, people were heeding the advice of officials and staying in. Microsoft, Amazon and many other top employers told their employees to work from home. The South Lake Union area, where thousands of tech workers typically fill the streets, was mostly empty.”
This is good public health practice, and it is appropriate for Seattle’s major employers to cooperate with government requests for social distancing. But this is going to be a huge problem for coffee shops and lunch spots in Seattle business districts, whose whole purpose in life is that there are people around. Workers here, too, are going to lose hours and tips and they’re going to need to pull back on their spending.
Every time a conference is canceled or another major city ends up needing to follow Milan and Seattle into social distancing mode, you’re going to get something similar. Meanwhile, we appear to be experiencing a general slowdown in the travel industry as businesses roll back on nonessential travel and people reconsider their vacation plans.
So far, most of the world is not impacted by social distancing, and white-collar workers in the impacted cities are just doing a lot of teleconferencing. But in the developed world, most people work performing in-person services — they’re in restaurants and retail stores, cutting hair, and taking care of children and the elderly.
You don’t need posit any kind of apocalyptic casualty rate to see that there’s going to be a huge economic problem if basically everyone all around the world ends up being encouraged to leave the house less and do less stuff. And the white-collar workers hunkered down with Slack and Zoom apps aren’t going to be left unscathed if nobody has money to buy stuff.
Interest rates are already very low
A textbook would, again, say that there is an obvious answer to the global demand crisis — major central banks should cut short-term interest rates.
Rate cuts would make all kinds of debt financed activity — business investment, new home purchases, buying a car, buying a major appliance, doing a home renovation — suddenly more attractive and create a new wave of demand to largely offset the problems induced by Covid-19.
The problem is that interest rates were already very low in most countries before coronavirus hit. Experts disagree on the reasons. But the fact that interest rates have been systematically higher in Canada and Australia than in the US, higher in the US than in Europe, and higher in Europe than in Japan suggests it may have something to do with population growth rates. Whatever the reason, the point is that there is not a lot of extra rate-cutting that can be done.
That doesn’t mean central banks are impotent at this point. But it does mean their ability to further boost the economy hinges on trying some unorthodox ideas that would be controversial and whose efficacy is debatable. The measures could involve central banks buying stock index funds (illegal in the United States but not elsewhere — and the law could be changed), trying to directly set longer-term interest rates (but these are also already low), or “level targeting,” in which central banks would promise to make up for any current inflation shortfall with extra inflation later (there’s a lot of concern that this would not be a credible promise to make).
What the world is going to need instead is fiscal policy.
America needs automatic economic stabilizers
The coronavirus-induced collapse in demand is a fully global problem that in some sense requires a global solution. And indeed virtually every big country could be doing more to stabilize demand.
Germany, in particular, is worth calling out because it is currently running a large budget surplus, and with interest rates in negative territory out to 30 years there would be no long-term cost to Germany to considerably increasing its spending.
Transportation analyst Alon Levy estimates that for about €60 billion Germany could build a comprehensive high-speed rail network that would better connect all its major cities and make domestic air travel obsolete. It could also offer international links to Copenhagen, Prague, Vienna, Zurich, Basel, Paris, Brussels, and Amsterdam. The German government should almost certainly do that regardless of the coronavirus situation, but a global demand panic would be a great time to announce it. The only problem with this plan is, frankly, that it’s not expensive enough, so Germany could also just cut taxes.
In the United States, the best ideas would probably be to send unrestricted funds to state and local governments to help defray the cost of coronavirus, throw everything possible at increasing zero-carbon electricity generation, and a temporary reduction in employer-side payroll taxes to discourage companies from laying people off.
But there’s a political problem in the United States. Right now, the Trump administration isn’t really asking for fiscal stimulus. But if it does, Democrats will have mixed feelings about it. On the one hand, it’s a good idea. On the other hand, there is limited appetite for helping Trump secure reelection — especially because Democrats know from bitter experience that congressional Republicans would never help a Democratic president stimulate the economy.
The right solution is to agree to fiscal stimulus but require it to take the form of creating new automatic stabilizers. Programs that will, in the future, trigger immediately, without any additional congressional action.
Last spring, the Brookings Institution think tank published an edited volume called Recession Ready that lays out a bunch of automatic stabilizer ideas. Among them one of the most important was developed by Claudia Sahm, a former Federal Reserve staff economist who’s now with the Washington Center on Equitable Growth. Her research created something called the Sahm Rule Recession Indicator, which serves as a good trigger point — historically, when the unemployment rate over the past three months rises at least 0.5 percentage points above the average over the past 12 months, a recession is imminent.
Sahm’s idea is that when the rule triggers, the federal government should send cash directly to every household.
Another, more technically complicated idea to implement, was developed by Georgetown University’s Indi Dutta-Gupta and involves providing federal subsidies to employers to create jobs.
One could argue until the cows come home about exactly what the best automatic stabilizer package is. But what’s clear is that it would be a good idea for Congress to work as quickly as possible on crafting one and passing it into law now before a possible recession.
That would put the US in position to respond quickly — indeed, immediately — if the unemployment rate does spike. Even better, the mere fact that a plan is in place could help bolster economic confidence and avoid a recession. And if there isn’t a coronavirus recession this year, there’s sure to be a recession at some point in the future. When it comes, we’ll be glad to have a program in place.
The biggest problem with creating an automatic fiscal stabilizer program, after all, has been that Congress doesn’t like to focus on things until there’s an emergency. The public health emergency has now arrived, meaning it’s a great time to start working on addressing the economic emergency before it’s too late.